What is the definition of surplus land?

Site Valuation: Methods and Application

Site Valuation: Methods and Application - Introduction

Site valuation, the process of estimating the economic worth of land separate from any improvements, forms a cornerstone of sound real estate appraisal. This chapter delves into the critical methodologies and practical applications underpinning this vital skill. Within the broader context of "Real Estate Appraisal Essentials: Foundations & Practices", and aligned with the course's goal of providing a comprehensive understanding of valuation, this chapter bridges theoretical foundations with practical tools needed for accurate site valuation.

The scientific importance of site valuation arises from its role in several key appraisal techniques, particularly the cost approach and building residual technique (both covered in detail in subsequent chapters). These methods depend on a separate, verifiable estimate of site value as a primary input. Further, as suggested by the course description, accurate site valuation is vital for "making informed decisions in this dynamic field." In addition, this chapter examines the context in which site valuation is legally mandated, such as in property tax assessment and condemnation appraisals, where a segregated valuation of land is essential to meet assignment requirements.

Building upon the concepts of the appraisal process outlined earlier in the course, including "understanding appraisal principles and standards," "crucial aspects like depreciation, economic obsolescence, and highest and best use analysis," this chapter guides the appraiser to apply "three approaches to value." By focusing specifically on the "Step 5 – Valuing the Site," a scientific methodology in determining the "site" value separately, the chapter directly relates site characteristics and external market data and its scientific importance with the overall appraisal task. It provides a systematic framework for analyzing "land that has been prepared for use or construction, as by clearing, grading, and provision of access and utilities."

This chapter's primary educational goals are to equip the learner with the ability to:

1. Define and apply the concept of highest and best use to site valuation, ensuring the most economically productive utilization of the land is considered.
2. Master key site valuation methods, including the sales comparison approach (highlighted in Chapter 3 description), allocation, extraction, development, land residual, and ground rent capitalization techniques.
3. Critically analyze the data requirements, strengths, and limitations of each method, facilitating informed decisions on the appropriate technique for different appraisal scenarios.
4. Articulate the scientific rationale behind each method and demonstrate their application through practical examples.

By exploring these methods within a rigorous scientific framework, this chapter will enable aspiring real estate appraisers to confidently and accurately determine site value, a fundamental skill for success in this dynamic and economically impactful profession.

Site Valuation: Methods and Application

## Chapter 6: Site Valuation: Methods and Application

**Description:** *This chapter delves into the critical aspect of site valuation within the broader context of real estate appraisal. Understanding the value of the land itself is fundamental to applying the cost approach, income capitalization techniques, and for various legal requirements. This chapter explores the concept of Highest and Best Use and its implications, then examines several recognized methods for site valuation, providing a comprehensive understanding of their application and limitations.*

### I. Highest and Best Use (HBU) Analysis: The Foundation of Site Valuation

#### A. Highest and Best Use Defined:

The **Highest and Best Use (HBU)** of a property is defined as the reasonably probable and legal use of vacant land or an improved property, which is physically possible, appropriately supported, financially feasible, and that results in the highest value.

**Mathematical Representation of Value Maximization:**

Let V represent the Present Value of a prospective use.
HBU seeks to maximize V such that:

V = Max [V₁, V₂, ..., Vₙ ]

Where V₁, V₂, ..., Vₙ represent the present values of n possible uses.

#### B. The Purpose of HBU Analysis:

*   **Value Driver:** The HBU dictates the fundamental economic engine that drives the value of real estate.
*   **Basis for Approaches:** HBU analysis influences the selection and application of the three appraisal approaches (Sales Comparison, Cost, and Income) by determining the most relevant comparables, replacement costs, and income projections.
*   **Consistent Use Principle:** It is critical for land valuation, guiding the separate estimation of land and improvements as per the Consistent Use Principle. This principle states that when an improved property is appraised, the value of the land and the improvements must be based on the same consistent use.

#### C. Characteristics of Highest and Best Use: The Four Tests

For a particular use to qualify as the HBU, it must satisfy these four criteria:

1.  **Legally Permissible:**

    *   **Definition:** The proposed use must be allowed under current zoning ordinances, deed restrictions, easements, and other applicable legal constraints. If the existing zoning prohibits the use, demonstrate a reasonable probability of obtaining a variance or rezoning.
    *   **Legal Theories:** This criterion directly relates to the *police power* of the state, enabling governments to regulate land use to protect public health, safety, and welfare.
    *   **Experiment:** Research local zoning regulations, building codes, and environmental restrictions. Analyze past zoning changes in the area to assess the likelihood of future zoning amendments.

2.  **Physically Possible:**

    *   **Definition:** The site must have the physical attributes to support the proposed use. Factors such as size, shape, topography, soil bearing capacity, drainage, access to utilities, and environmental conditions are considered.
    *   **Scientific Principles:** Soil mechanics and engineering principles dictate the feasibility of construction based on soil characteristics. Topographic analyses (slope, aspect) influence site development costs.
    *   **Experiment:** Conduct a preliminary site investigation, including soil testing, topographic surveys, and utility availability assessments.

3.  **Financially Feasible:**

    *   **Definition:** The proposed use must generate sufficient income or benefits to justify its development costs, including construction costs, operating expenses, taxes, insurance, and a reasonable return on investment.
    *   **Economic Modeling:** Financial feasibility is assessed using discounted cash flow analysis, considering the time value of money, risks, and opportunity costs.
    *   **Mathematical Representation:** Net Operating Income (NOI) should be sufficient to exceed all associated expenses, including those related to debt service.
        `NOI > Debt Service`
    *   **Experiment:** Prepare a pro forma income statement projecting revenues and expenses for the proposed use over a reasonable investment horizon. Calculate the Net Present Value (NPV) and Internal Rate of Return (IRR). The use is considered feasible if the NPV is positive and the IRR exceeds the required rate of return.

4.  **Maximally Productive:**

    *   **Definition:** Among all legally permissible, physically possible, and financially feasible uses, the HBU is the one that results in the highest present value for the site.
    *   **Optimization Theory:** This criterion involves optimizing resource allocation to maximize output (property value).
    *   **Experiment:** Compare the NPVs of all feasible uses and select the one with the highest NPV.

#### D. Principle of Anticipation:

The *Principle of Anticipation* emphasizes that value is based on the anticipated future benefits of ownership. The highest and best use analysis must consider future changes in market conditions, zoning regulations, or physical characteristics of the site.

#### E. Interim Uses:

If a temporary use is warranted in advance of realizing the HBU, it is called an interim use.

### II. Vacant Land vs. Improved Property: HBU Considerations

#### A. Separate HBU Analyses:

*   **Land as if Vacant:** Determine the highest and best use assuming the site is vacant and available for development.
*   **Property as Improved:** Consider the existing improvements and whether they contribute to or detract from the overall value. Demolition costs must be factored into the analysis.

#### B. Legal Nonconforming Uses:

*   **Definition:** A use that was legal at one time but no longer conforms to current zoning regulations. Such uses are often "grandfathered in," but expansion or alteration may be restricted.
*Implication:* In an appraisal, a legal nonconforming use may be the HBU as *improved* but cannot be the HBU as *vacant.*

#### C. Consistent Use Principle:

The appraiser must adhere to the Consistent Use Principle, ensuring that both the land and improvements are valued under the same highest and best use scenario.

#### D. Excess Land and Surplus Land:

*   **Excess Land:** Land that has the potential to be sold separately and be valued at the HBU.
*   **Surplus Land:** Land that does not have the potential to be sold separately, and generally has little or no value.

#### E. Plottage Value:

Plottage Value recognizes that combining two or more contiguous parcels of land may create a larger site with greater utility and value than the sum of the individual parcels.

#### F. HBU in Residential Appraisals: Simplified Application

Unless the appraisal states otherwise, if HBU:
* Value as if improved is higher than the value as if vacant, and:
* Similar sales of comparable housing with a similar number of bedroom and bathrooms exist, then
the current residential use is considered HBU.

### III. Methods of Site Valuation: Applying the Principles

#### A. Sales Comparison Method: The Primary Technique

The Sales Comparison Method involves analyzing recent sales of comparable vacant land parcels and adjusting their prices to reflect the characteristics of the subject site.

**1. Data Sources:**
* County tax assessor
* County deed records
* Title companies
* Professional online data providers
* Brokers and developers
* Multiple Listing Services

**2. Applying Data from Sales of Improved Properties:**

This is most applicable when the value is driven primarily by the site and not the structures. The value of the site is calculated as Sale Price - Cost to Demolish Structures

**3. Elements of Comparison:**

*   **Real Property Rights Conveyed:** Fee simple, leasehold, etc. Adjust for differences in ownership rights.
*   **Financing Terms:** Adjust for atypical financing (e.g., seller financing, below-market interest rates).
*   **Conditions of Sale:** Arm’s length transaction? Adjust for duress, family relationships, or other unusual circumstances.
*   **Expenditures Immediately After Sale:**
Adjust the sale price for expenses necessary after the transfer of title.

*   **Market Conditions Adjustment:** Account for changes in market conditions (e.g., inflation, supply/demand shifts) since the date of the comparable sale.

**Mathematical Adjustment Formula:**
  `Adjusted Sale Price = Sale Price x (1 + Market Change Rate)`

*   **Location Adjustments:** Account for differences in neighborhood desirability, access, zoning, and other location-specific factors.
*   **Physical Characteristics:** Adjust for differences in size, shape, topography, soil conditions, frontage, views, and other physical attributes.
*   **Economic Characteristics:** These refer to conditions such as income, expense and property management.

**4. Comparable Sale Price Adjustments:**

*   **Linear Regression Analysis:** A more sophisticated method using statistical analysis to quantify the relationship between site characteristics and value.

#### B. Allocation Method: Ratio-Based Estimation

The Allocation Method assumes that a certain percentage of the total property value is attributable to the land. This percentage is derived from market data on comparable properties. This method is most useful in communities with a high number of cookie-cutter homes.

**Mathematical Formula:**

Land Value = Total Property Value x Allocation Percentage

#### C. Extraction Method: Residual Value Calculation

The Extraction Method involves subtracting the depreciated cost of the improvements from the total property value to derive the land value.

**Mathematical Formula:**

Land Value = Total Property Value - Depreciated Cost of Improvements

#### D. Development Method: Anticipating Future Value

The Development Method (Subdivision Analysis) estimates the value of land suitable for subdivision or development. It involves projecting the revenues from the sale of finished lots, subtracting development costs (including construction, marketing, financing, and entrepreneurial profit), and discounting the resulting cash flow back to the present value.

**Mathematical Representation (Simplified):**

Present Value of Land = (∑(Projected Sales Revenue - Development Costs) / (1 + Discount Rate)^t ) - Entrepreneurial Incentive

Where 't' represents the years

#### E. Land Residual Method: Isolating Land Income

The Land Residual Method separates income between the land and the improvements to value the land.

**Mathematical Formulas:**

1.  **Calculate Income Attributable to Improvements:**

        Improvement Income = Improvement Value x Improvement Capitalization Rate

2.  **Calculate Income Attributable to Land:**

        Land Income = Total Property Income - Improvement Income

3.  **Calculate Land Value:**

        Land Value = Land Income / Land Capitalization Rate

#### F. Ground Rent Capitalization:

Ground Rent Capitalization estimates land value by capitalizing the income generated by a ground lease.

**Mathematical Formula:**

Land Value = Ground Rent / Capitalization Rate

#### G. Depth Tables (“4-3-2-1 Method”): Heuristic for Depth Adjustments

Depth tables provide a percentage adjustment based on lot depth. For example, the 4-3-2-1 method assumes the front quarter of the lot is worth 40% of the total value, the second quarter 30%, the third 20%, and the final quarter 10%. This is often used for linear commercial front footage properties, and may not be applicable to residential properties.
### IV. Conclusion
Site valuation is a multifaceted process that requires a thorough understanding of the HBU, market conditions, and appropriate valuation methods. By applying these principles and techniques, appraisers can accurately estimate the value of land and provide credible support for their appraisal opinions.
### V. Chapter Quiz
1. The principle of highest and best use states that the value of a property is based on:
    a) Its historical cost.
    b) The use that is reasonably probable, legally permitted, physically possible, financially feasible, and results in the highest value.
    c) The use that generates the most income in the short term.
    d) The use that is most aesthetically pleasing to the appraiser.
2. Which of the following is NOT a test for the HBU?
    a) Legally permissible
    b) Maximally productive
    c) Physically possible
    d) Architecturally Sound
3. A property's current zoning is residential, but it would be more valuable if used commercially. To account for this, an appraiser should:
    a) Ignore the zoning restriction and appraise the property based on its commercial potential.
    b) Consider the probability of rezoning and incorporate the cost of demolition into the valuation.
    c) Assume the current residential use is the HBU, regardless of its commercial potential.
    d) Contact the city and inquire about rezoning, which can have no influence on the report.
4. In the allocation method, land value is estimated based on:
    a) Its unique physical characteristics.
    b) A standard ratio between the value of land and the value of improvements in similar properties.
    c) A fixed percentage set by local zoning regulations.
    d) The opinion of the person living next door.
5. Excess land is generally:
    a) Essential for the property's current use.
    b) Not needed for the primary HBU of the site.
    c) Sold separately or combined with adjoining properties to increase utility and value.
    d) Answer B and C
6. Plottage value refers to:
    a) A decrease in value resulting from combining two properties.
    b) The increase in value resulting from combining two or more properties.
    c) The value of a plot of land as assessed by the tax authorities.
    d) None of the above
7. To apply the Land Residual Method, an appraiser must first determine:
    a) The number of parking spaces on the site.
    b) The height of the tallest building nearby.
    c) The income attributable to the improvements on the land.
    d) All of the above
8. Ground Rent Capitalization is a method based on:
    a) Historical cost of improvements.
    b) The rental income generated by a long-term ground lease.
    c) Market value for improvements.
    d) Local property tax rates.
9. Under which circumstance can data from the sales of improved properties be used to determine site value?
     a) Data from sales of vacant properties cannot be used under any circumstances.
     b) When the building in a sale of improved properties is to be immediately demolished.
     c) The property's local zoning rules prevent it.
     d) If that is the appraiser's only source of available data.
10. How does the 4-3-2-1 Depth Table factor into land valuation?
     a) By determining how much of the front footage of a linear property has a proportional impact on a property's value.
     b) By providing an exact measurement of how deep the property's foundation should be.
     c) By indicating the exact location where utilities can be accessed.
     d) Through calculation of the property tax burden.

Scientific Summary: Site Valuation: Methods and Application

This summary focuses on the chapter "Site Valuation: Methods and Application" from the training course "Real Estate Appraisal Essentials: Foundations & Practices." It aligns with the course description, which emphasizes understanding appraisal principles, valuation methods, and critical aspects like highest and best use analysis to accurately assess property value.

Main Scientific Points:

• Highest and Best Use (HBU) is Foundational: The chapter establishes HBU as the cornerstone of site valuation. HBU, defined as the legally permissible, physically possible, economically feasible, and maximally productive use, dictates the potential value of a site. This concept is directly relevant to the course's focus on appraisal principles and the ability to make informed decisions.

• HBU Determination Process: The determination of HBU involves a systematic elimination of infeasible options based on legal, physical, and economic constraints, followed by analyzing the most profitable use. This aligns with the course's goal of providing a structured approach to real estate appraisal.

• Vacant vs. Improved Site Analysis: The chapter emphasizes the distinction between analyzing a site as if vacant and as currently improved. This distinction is crucial, particularly in the context of depreciation and economic obsolescence, key elements highlighted in the course description. The concept of "interim use" is introduced to address situations where the present use is temporary, pending a more profitable future use.

• Site Valuation Methods: Several methods for site valuation are presented, each relying on different data and analytical techniques:

  • Sales Comparison: The most reliable method, directly comparing the subject site with similar sold sites, adjusting for differences (location, time of sale, etc.). This connects with the course’s mention of comparative approaches to property valuation. The chapter also goes over “Elements of Comparison” and proper market area extraction.
  • Allocation: A rule-of-thumb method using a ratio to allocate a portion of improved property value to the land, providing quick but coarse values.
  • Extraction: Deriving land value by subtracting the depreciated value of improvements from the total property value.
  • Development Method: Estimating the value of raw land by deducting development costs from the projected sales of finished lots (subdivision analysis). This approach utilizes discounted cash flow techniques and provides the least errors.
  • Land Residual: Isolating the land-related income stream and capitalizing it to find land value.
  • Ground Rent Capitalization: Capitalizing ground rent from a land lease to estimate land value.
  • Depth tables, show a relationship between depth and property value.

• Importance of Sales Comparison: The chapter clearly asserts the primacy of the Sales Comparison method. All other methods are considered secondary, used when sales data is lacking, or as a support for sales method conclusions.

Conclusions and Implications:

• Accurate site valuation hinges on a rigorous analysis of HBU, which guides the entire appraisal process, particularly the selection of comparable properties and the application of valuation methods.
• The choice of site valuation method depends on data availability and the nature of the appraisal assignment. The Sales Comparison method is the preferred approach.
• The chapter equips students with practical tools and techniques for assessing property value, essential for navigating the complexities of real estate appraisal, as stated in the course description.

Relevance to Course Description:

• Appraisal Principles and Standards: The chapter reinforces the core appraisal principle of HBU and its application to site valuation.
• Valuation Methods: A detailed review of the six common methods for determining site values provides a structured approach for mastering key valuation techniques.
• Depreciation and Obsolescence: The consideration of improvements in highest and best use analysis directly relates to the concepts of depreciation and obsolescence.
• Highest and Best Use Analysis: The emphasis on HBU as a central concept aligns directly with the course's stated learning objectives.
• Practical Tools: The presentation of various site valuation methods provides the necessary practical tools for making informed decisions in real estate appraisal.